Making Demands on Diversity

Rogers: "We are just not fighting hard enough."

Last fall, John Rogers of Ariel Investments found a convenient forum to discuss the state of diversity in finance. At a SIFMA diversity conference last October, he scolded executives and the rest of the industry about the woeful numbers from under-represented groups in senior roles. "The state of diversity in the industry," he reportedly said, "is appalling."  He added, "Ninety percent of leaders talk a big game, but...we have gone backwards. We are just not fighting hard enough."

Rogers is Ariel Investments' founder and CEO. He, also, happens to be a pioneering African-American in the industry, one who has been a prominent investor and leader in mutual funds for 30 years. Hence, Rogers is no new kid on the block, not an industry novice who just appeared on the scene to make this striking, candid observation.  He has seen dozens of market trends and phenomena, endured more than a few volatile markets, and followed a few decades of diversity patterns. The patterns, he says now, appear to be as unsettling as occasional market collapses.

He stepped into the investment arena in the 1980s, and with sufficient backing and varied contacts courageously started his own mutual-fund company in 1983. Like many minorities who surfaced on Wall Street (or in Chicago, where he has always been headquartered) years ago, Rogers perhaps had high expectations regarding diversity. Perhaps he expected over three decades, minorities would have prominent, visible, and impressive roles in every senior niche in every aspect, perch or segment of finance--in banking, trading, investing, funds management, securities processing, etc. Everywhere.

Three decades would have been ample time for the first wave of large numbers of minorities and women in finance to appear now in substantial numbers in board rooms, corner officers, and trading rooms. Within three decades, blacks, Latinos, Asians and women should have prominent roles within  those hush-hush huddles that determine who gets promoted, who gets paid handsome bonuses, who is tasked on headline-wining deals, and who gets the precious amounts of capital that is allocated for business expansion and investment.

But in 2012-13, he tells eFinancial Careers: "It's unfortunate. One of the most lucrative parts of the economy; it's so dynamic, offering so much wealth, and people of color have not participated."

He adds, "Here in Chicago, at so many funds and banks, you can count the number of black partners on one hand.  That's just the reality of it. It's something that needs to be addressed.  People aren't demanding that industries reflect the societies in which they live."

In perhaps the final chapters of his career, Rogers is recommending that those in positions of influence should call for or take bold action: Make stronger demands, ask questions, and push harder for banks, firms and funds to do something. He recalls an occasion recently where, in working with a bank on a specific negotiation, he asked curtly why he didn't see minority representatives. By the next meeting with the same investment bank, he said, the firm had hired its first black banker.

Why might it be time for bold, aggressive tactics? Why do his words resonate? It's likely frustration and disappointment after so many years of effort. It's the puzzlement about what can be done and where do go from here, especially as major institutions struggle with current business models and announce lay-offs routinely. It's also the squashing of lofty expectations from the 1980s and 1990s, when banks and Wall Street firms opened their doors (with some outside thrusts, of course) to minorities and women and welcomed them to entry-level analyst and associate programs. They hustled to find competent, diverse talent, while at the same time, the talent sought them out.

The expectations then were that after 10-15 years of doing deals, managing portfolios, teams and large client relationships, trading large sums (in the tens of millions), doing research, making sales calls, overseeing complex financial models and advising on investments, the vast wave of minorities would now be running operations, sectors, business segments, subsidiaries in Europe or Asia, or much of the firm itself.  They would be the ones with significant roles in deciding how to restructure a large banking unit, deciding whether to acquire other funds or banks, or deciding where to invest billions of dollars of capital over the next few years.

Granted, there are some minority and women bankers in such roles. And some have risen to the top echelon--either leading the institution (American Express or Merrill Lynch, e.g.) or leading an entire sector (investment banking at Citi or Credit Suisse, e.g.). (Women have previously held the CFO slots at Citi, Morgan Stanley, Lehman, and JPMorgan Chase and chief risk roles at Lehman and BoA.) But expectations had been much higher long ago, because many thought the hardest part about Wall Street was simply getting through the door.

In ensuing years and even today, getting into a lucrative Wall Street spot is still complex, agonizing and difficult. Yet retention and promotion to the top rungs remain even more complex, agonizing and difficult.

Diversity initiatives, retention efforts, networking, and mentoring programs sometimes work. They pave the way for opportunity, provide support and encouragement, and help instill confidence in those who sometimes shrug and want to give up.  Rogers now suggests that all these efforts, and more, need to be capped off with strong demands.

Many institutions nowadays are struggling with reorganizations and uncertainty about reform, but with improved market conditions, they don't have the excuse of having to fight for survival while the financial system is about to collapse.  To their credit, most major financial institutions devote enormous amounts of time, funds and priorities to diversity. And they support internal "affinity" programs to provide career support for women and professionals of color. On the other hand, private-equity firms, financial sponsors, hedge funds  and venture-capital firms, often indifferent about such initiatives, operate as if it were the 1970s.


The pipeline continues to dwindle at mid-levels, as senior associates or junior vice presidents, including women and minorities, become discouraged about senior opportunities or pathways to managing director or become more demoralized, disenchanted, marginalized, or "plain ol' tired" of figuring out how to get to that top echelon. Many depart before they reach their fifth anniversary in the firm.

Thus, throughout the year, when institutions explore the candidates eligible for promotion to the top ranks, many women and minorities have already opted out or the few who remain are not well known to many or don't want to expend the enormous emotional energy to fight the fight.

Rogers suggests institutions and funds--big and small and in all facets of the industry--need to go beyond the placid endorsement of programs. They need a swift kick sometimes in the rear to be reminded that all can do better. All must do better.

Tracy Williams


See also:

CFN: Affinity Groups at Major Institutions, 2011
CFN: Venture Capital and Diversity, 2011
CFN:  Diversity Update, 2011
CFN:  Diversity:  Staying on the Front Seat, 2009

Today's "Bulge Brackets"

Who comprises the Bulge Brackets of 2013?

"Bulge brackets" in investment banking was once an acclaimed list of investment banks that dominated most of the activity in the industry--from staid, conventional bond underwriting to mergers-and-acquisition advice to flamboyant IPOs.  "Bulge bracket" signaled dominance and prestige. It implied a bank was a major player. Statistics and market share determined who made the list or not, and it was often a moniker awarded to banks that finished in the top five in most finance categories.

Say "bulge bracket" and those who trade and do deals and those who follow the industry think immediately of Goldman Sachs and Morgan Stanley.  Just a few years ago, Lehman Brothers and Merrill Lynch were "bulge bracket" mainstays.  Go back decades, and banks such as Salomon Brothers, Drexel Burnham, First Boston, and DLJ might have squirmed their way into a top-5 listing. Often they did, back then. Today, they don't exist or were absorbed into oblivion long ago.

Over the years, MBAs in finance with eyes toward Wall Street often wanted to work at "bulge brackets," because they were movers and shakers, the behemoths that shaped, dominated and influenced corporate and municipal finance. They were the firms that generated the most revenues, carved out the greatest market shares, swept up much of the prestige in doing deals, and--to the delight of MBAs wanting to work there--paid the biggest bonuses.

The term is not used as much today. Some still use it, but the financial media don't flaunt it as much, if it all. That's likely because of (a) the disappearance of some of those storied names in American finance (Salomon and Lehman, e.g.), (b) the dominance of banks with commercial-banking heritages on current lists (JPMorgan, Citi, Bank of America, Deutsche and UBS, e.g.), (c) the continuing blending of traditional investment- and commercial-banking roles, and (d) the ongoing uncertainty of who will survive rapid changes in the industry. 

In the past and even today, if there were one list bankers wanted to dominate, it was often the list of M&A advisers. Mergers and acquisitions in investment banking has often been the heart, soul and core, not because they generated the most revenues, but because M&A bankers have a direct line to CEOs of the client companies.

M&A bankers strive to be the conscience guiding the CEO and board members on corporate strategy, business expansion, new investments and significant acquisitions. They steer CEOs, knowing that CEOs, too, can direct other business to the bank--business including bond underwritings, project finance, new equity offerings, and corporate lending.

The "bulge brackets" in M&A activity today include the same, familiar names (Goldman Sachs and Morgan Stanley). Meanwhile, institutions with traditions in commercial banking or foreign operations have shoved their way to spots near the top. After they decided in the late 1990s to exploit their large capital bases and balance sheets and thanks to loosened regulation, these institutions (the JPMorgans and Citis) earned lead roles in underwriting activity (especially in bonds and loans) and found a back door into strategic M&A. It also helped, too, when they raided other investment banks for top talent or acquired other established investment banks to propel them through M&A doors. 

In 2012, Goldman Sachs and Morgan Stanley were the top two M&A banks (according to Thomson Reuters), based on total deal value.  Not a surprise.  JPMorgan and Citi rounded out the top 5. Also not a surprise.  Barclays emerged as no. 3--a surprise leap, spurred mostly by a surge of activity in the U.S.  The M&A unit at Barclays, remember, includes bankers with old Lehman ties after Barclays acquired Lehman's U.S. broker/dealer during the financial crisis, 2008.

At Bank of America, its Merrill Lynch unit seems not to have had a similar influence--at least in M&A.  BoA slipped to 8th in recent lists.

Some juggling and repositioning should continue into 2013, because all of the above are scratching their heads figuring out the impact of regulation and straining to squeeze more revenue out of an uncertain business model. Even this week, Morgan Stanley hinted that it needed reduce the scale of its fixed-income unit.

All of the above, as well as Credit Suisse, Deutsche, and UBS (three more names also in the top 10), are major financial institutions, subject to tough capital and liquidity reforms called for by Basel III and Dodd-Frank. Hence, in 2013, all activities in investment banking--from trading to underwriting and strategic advisory--are on the table, subject to revamping if necessary to reach return-on-capital targets.

UBS is in a peculiar place. It claims to be doing now what other banks will need to do over the next two years--withdrawing from any investment-banking activity it can't rationalize. Nonetheless, in 2012, it ranked as a major investment bank--at least based on league tables. It placed 9th in M&A activity--garnering a notable share of deals, especially in Asia.  In late 2012, it made prominent announcements about vast reductions in investment-banking staff--especially in fixed-income markets.

It may still choose to support its mergers team, because M&A requires less capital and hardly needs use of the balance sheet. But trends today suggest that being big in all other investment banking units (including corporate lending, mezzanine financing, bond underwriting) helps drive M&A--not necessarily the other way around.

Meanwhile, don't discount the "boutiques."  They lack capital. They can't swing for the fences with big balance sheets, nor can they provide bridge loans or mezzanine financing to clench deals or get them done quickly. (Lazard and Evercore rank in the top 13 among M&A advisers.) Their bankers are the ones who whisper to CEOs they do deals without the blatant conflicts of interests the "bulge brackets" often have.

And just as important, because they are organized in simple structures without trading arms, lending units, and armies of industry teams, "boutiques" are not subject to the vast amounts of regulation, reform and re-engineering "bulge brackets" will encounter this year and the year after and the year after that.

Tracy Williams

See also:

CFN:  Morgan Stanley: Can It Please Analysts? 2012
CFN:  UBS Throws in the IB Flag, 2012
CFN:  Goldman Sachs: How Does It Do It? 2010
CFN:  Banking Boutiques: What Are the Advantages? 2009

A Quick Glance Back at 2012

How will 2012 be remembered in the annals of finance?

In the annals of finance, 2012 was eventful, but won't be remembered as remarkable. The year won't deserve a chapter in economics texts or finance history (like the years 1987, 1998, 2001, or 2008). The financial system didn't collapse, and equity markets, although sometimes unsettled by volatility and uncertainty, didn't fall through a sinkhole.

No major financial institution went bankrupt; many continued to improve their balance sheets and narrow their business scopes.  Deals got done, although at a pace still far below the torrid mid-2000s. China proved to be human--at least in economic prowess. Brazil was proclaimed a favorite emerging market. Interest rates remained near zero, and banks remained squeamish about the burdens of new regulation.

A few events, trends or phenomena, nonetheless, will stand out. Every year something unexpected occurs, a close-to-black-swan event (the large, breath-taking losses at JPMorgan). Every year something that was supposed to proceed smoothly hits a sudden, rough patch (Facebook's IPO, projected in 2011 to have a blazing 2012 launch).

Facebook's Fumble. Everybody who has anything to do with equity markets counted down the days  until Facebook's springtime opening day:  underwriters, traders, market-makers, brokers, investment managers, Facebook employees, financial consultants and hedge-fund traders. And then the company fell flat on its face out of the starting blocks. For weeks, fingers pointed everywhere at lead underwriter Morgan Stanley and at the stock exchange Nasdaq to determine what went wrong and why.

Facebook's stock price nose-dived initially and then bounced around thereafter for months. It has since settled near its first-day offering price. The industry continues to assess what happened and define the lessons learned from what appeared to be a botched underwriting. Morgan Stanley and its lead-underwriter team, many said, had over-priced the stock. Nasdaq, many thought, was clumsy in opening-day trading because of systems problems.

Morgan Stanley, this week, continues to feel some repercussion. Regulators in Massachusetts fined the firm on how it managed the IPO. 

(See also:
CFN: Facebook IPO: What Went Wrong?
CFN: Facebook's Underwriters)

JPMorgan's Whale of Losses. JPMorgan's senior managers didn't see the "big whale" coming last spring. The announced $4 billion-plus in losses turned out to be a financial sock to its face, if they didn't tarnish its reputation for a month or two.  In 2012, the big whale couldn't restrain himself, kept selling certain credit-default swaps uncontrollably.  It turned into the big trade that went badly awry.

The trade started off as a basic hedge against risks in its loan and bond portfolio, but exploded into billions in trading losses. It resulted in job losses for many, inquiries from regulators, and befuddlement from outsiders that had assumed that JPMorgan's CEO Jamie Dimon had a tight rein on all matters inside the JPMorgan machine--including risk management.

Once again, the misunderstanding of exotic financial instruments led to losses and red faces from bankers and traders who thought they had everything within grasp.

JPMorgan decided to come clean, rid itself of the positions, revamp the entire unit, and simplify the role of credit hedges in risk management. This week, it reported that it had off-loaded the positions to a hedge fund, which has sold down the whole portfolio.

A lesson learned for managers of credit and market risk. But is it? Is it a lesson that will have been forgotten when we hear about the next billion-dollar loss?

(See also:  CFN: Where Was the Risk Management Unit?)


A Resignation Heard Round the World. Remember Greg Smith? Frustrated with what he saw and experienced at Goldman Sachs, he announced his resignation in front of millions of New York Times readers. In an op-ed piece in early 2012, he described a client/firm culture that, he alleged, put the firm far ahead of the client. He was peaking in his career in equity-derivatives sales, decided he couldn't bear what he observed and submitted his reflections on resignation to Goldman and The Times' editors, who readily published it.

The op-ed column eventually turned into a book, Why I Left Goldman Sachs, a book tour and an appearance on CBS-TV's "60 Minutes." Critics lampooned the book, not because he wrote carelessly of his experiences, but because they found no incidences where Goldman could be accused of illegal banking. While they found little they considered "juicy," the book goes onto the shelf alongside Michael Lewis' 1980s' Liar's Poker, which could have been titled Why I Left Salomon Brothers. 

What's next for Smith? Another book. Another career. Anywhere, but Wall Street.

(See also CFN: Greg Smith and His Letter to Goldman.)

Libor in Turmoil. Before 2012, most laymen outside of finance knew little or nothing about Libor--interest rates for corporate borrowers, pegged by a club of banks in London. Many in finance knew of Libor. Few could explain how it was founded, derived, and/or agreed upon.  Many knew that corporate bonds, corporate loans and mortgage-related securities and loans were tied somehow to Libor rates. A few knew how Libor determined values of interest-rate swaps and other interest-rate derivatives (including futures, caps and collars).

Nobody expected 2012 would be engulfed by a Libor-related scandal that ultimately sacked the CEO of Barclays (Bob Diamond) and led to calls for sweeping changes in how Libor is calculated or whether Libor should be replaced by something else.  As the year ends, Libor continues as an agenda item in 2013, and UBS has stepped up to pay a large fine, as Barclays did. Whispers suggest there is more to come.

(See also CFN:  Libor in Crisis)

Knight's Dark Day. JPMorgan's wasn't the only institution that was pummeled with sudden trading losses.  JPMorgan's "whale" losses eventually exceeded $5 billion, but never jeopardized the bank's existence.  Knight Capital, a market-maker in equities, launched a new electronic trading scheme with the New York Stock Exchange this past fall. But within an hour of unveiling it, it suffered technical glitches and had to absorb $440 million in trading losses that almost put the firm into bankruptcy. 

Knight's board, investors, lenders and counter-parties huddled all weekend to resuscitate the firm, inject more capital, and give it a second life.  Knight survived, but for weeks thereafter, the global debate on trading markets revolved around electronic and high-frequency trading:  Does speed-trading jeopardize the integrity of markets? Will high-frequency, electronic trades shove aside and discourage retail investors?  Should governments move rapidly to corral this activity?

Knight is humming along now; in recent days, the firm announced discussions with Getco, the high-frequency trading firm, to merge in the new year. The trading glitches forced eventual merger discussions, but the rationale is likely also two firms meshing together their counter-parties, systems technology experts, and respective market niches to make them even stronger, better in, yes, high-frequency markets.

(See also:  CFN:  Knight's Darkest Moment
CFN: What's Next for High-Frequency Trading)

Apple's Stash of Cash.  Apple survived the year with the absence of Steve Jobs.  Depending on the day of the week, it claims the highest market value of any corporate enterprise around. Throughout the year, it was flush with cash, billions on top of billions, not sure what to do with it:  Invest? Acquire something? Build more new gleaming, white stores? All of the above? Or pay dividends to dividend-starved shareolders? Or buy back stock?

A delightful corporate-finance challenge it had for much of the year.  It decided it was okay to reward shareholders (with Jobs not around to veto the move), as it contemplated and unveiled dividend and buy-back programs, while still being able to hold unto more billions in cash on the balance sheet.

(See also:  CFN:  Apple's Stash of Cash--What to Do With It?)

And for those aspiring for the grand old days of investment banking, whether they hark back to the 1980s of management buy-outs and bridge loans, the flurry of dot-com IPOs of the 1990s and early 2000s, or the exotic structures of mortgages or synthetic creations of Ph.d bankers of the mid-2000s, the signals everywhere were sour in 2012.  Week after week, big banks announced lower bonuses and significant layers.  The economy was in recovery, and markets improved. But new regulation is strangling the existing investment-banking business model.

UBS's Surrender. By late fall, UBS led the way with its huge-scale downsizing in investment banking. Others would follow later, from Credit Suisse to Barclays. Others, like Jefferies and other boutiques, will try to fill the gaps or capture market share where they can.

Investment banking and sales & trading at big banks will need to reinvent itself in 2013, and it's driving all crazy that they haven't figured out what that invention should be. 

(See also:  CFN:  UBS Throws in the IB Flag)

Tracy Williams
___________________________________


See also:
CFN:  MBAs Gear up for 2013

MBAs Gear Up for Summer, 2013

Now is the time to prepare for interviews

Most MBA students know that to secure the right job in financial services, you can't stroll out of the classroom, jump into an interview suit, and glide into a round of interviews.  Preparation is critical. You don't secure the dream job with a few practice sessions of the elevator speech.

One of the best ways to gear up and prepare for the rigors of recruiting season is to have a useful framework, one that you can use to formulate a strategy, demonstrate expertise, and express a self-brand. The goal is to get from campus to a significant summer internship in finance in investment or corporate banking, investment management, private equity, asset management or corporate finance.  Indeed in the post-crisis environment of 2013, the world of finance has emerged from the abyss, but opportunities continue to be fleeting, segmented and scarce.  Approaching interviewing season with strategy, framework, optimism and unbridled confidence can go a long way. Not to mention a proven mastery of technical skills.

The Consortium Finance Network hosted its second annual fall webinar on "Internships and Recruiting" Dec. 11 to help first-year Consortium MBA students in finance plan for the upcmoing interviewing season and emerge with offers from their top-choice institutions.  CFN hosts Camilo Sandoval, D-Lori Newsome-Pitts and Tracy Williams welcomed panelists Eric Lane and Mark Santos, recent Consortium graduates and led an hour-long discussion to launch the 2013 recruiting campaign.  For the MBA students participating, panelists provided stories and advice from their own successful campaigns to win job offers.

Lane is an associate in M&A and equity finance at Loop Capital in Chicago, a mid-size investment bank. Santos is in corporate finance at Dell, the computer company. Both entered business school at the height of the crisis and were able to use effective strategies to get from campus to positions in finance during a time when it seemed as if nobody was hiring.
 
CFN's framework for approaching interviewing season revolves around the MBA student demonstrating competence, experience or expertise in five pillars:

(a) background, 
(b) interest, 
(c) drive, 
(d) capability and 
(e) insight.  

The financial institution, whether it's Morgan Stanley or Loop Capital, is evaluating the candidate, in most cases, in those five broad categories. The successful candidate demonstrates excellence across the board throughout the process. The process includes information interviews, first-round interviews, and call-back, on-site interviews.

CFN, during the webinar, showed how MBA students, in numerous ways, can show excellence in each area.  Knowing that interviewers, for example, are seeking to detect interest and drive, MBA students should seize the process, demonstrate interest and drive and do it frequently.

Lane advised MBA students to look beyond the better-known institutions, the bulge-bracket firms such as Citi and Goldman Sachs, and explore working, too, at niche firms, regional firms, and boutiques.  Loop Capital is an example, as well as such firms as Lazard, Greenhill, M.R. Beal, and Evercore. Opportunities may exist outside the well-worn paths and may afford visible, broad roles for first-year MBA associates.

Santos advised MBA students interested in finance to take steps even beyond financial institutions and examine roles in corporate finance, corporate development, M&A and strategy within client companies--the industrials, the manufacturers, and the technology companies, such as, say, Dell, IBM, Pepsico or Eli Lily.  The companies have critical roles in corporate finance and ultimately choose to work directly with investment banks for advice or financing.

The formal interviewing season for MBA summer internships usually starts immediately after fall exams. The process accelerates in January. Major financial institutions have already identified some candidates they covet and desire to see on interview lists. They will inform some of them they have been invited to interview on "A" lists.  Candidates not on these lists can still seek interview slots in other ways. Smaller firms and corporates proceed with a different recruiting agenda and timetable-- partly because they have fewer slots and opportunities. 

Second-round interviews, where MBA candidates are brought on site, can occur from mid-winter until early spring. Many MBA graduates have told legendary stories about their interviewing experiences--often unique, sometimes memorable--to convince a Goldman Sachs, Credit Suisse, or Wells Fargo to hire them. Some have told about enduring sessions to show how they "think on their feet," how they would manage a trade or deal transaction, or how they would respond in a market crisis.


Throughout it all, successful candidates in the past had a few things in common:  a clear goal, a workable strategy, and a useful framework, all on top of networks, mentors, and special ties inside some institutions. Most successful candidates also had a passion for finance, boundless knowledge about markets, trends and products, and glowing confidence.

During the webinar, panelists and hosts reminded students of the importance of demonstrating knowledge and polishing it with rational viewpoints about markets, past transactions, and economic trends. An informed opinion shows candidates have thought about the topics of the moment and conveys leadership potential. Panelists also reminded students to concentrate on how to stand out and differentiate among others vying for the same spots. Demonstrate excellence, but distinguish yourself. However you look at it, it's a competition.

The webinar presentation and recording will be available to students who registered for the event and to others upon request (through the CFN's Linkedin page).

Tracy Williams

See also:

CFN:  Internships and Recruiting, Fall, 2011
CFN:  MBA Job Hunting, No Need to Panic Yet, 2012
CFN:  The Toughest Interviewers, 2012
CFN:  Mastering Technical Skills, 2010

Bring on 2013: Cliffs, Reforms, Recovery

What lies ahead in finance?

After a long haul and after markets watched and studied the results, we've jumped the hurdle of the presidential election. We now head toward a year-end where sound bites and gurgles of noise from Washington scream "fiscal cliffs" and a possible end-of-world scenario if legislators don't reach an agreement and unveil a fiscal plan before January 1.

Often in an election year, capital markets and finance managers go through pauses, starts and stops. They gauge the political winds that will affect economic recovery, interest rates or the tendencies for companies to invest in growth, merge with others, borrow long term or issue new stock.

The election is done, and it's time to bring on 2013, of course, after legislators cease jousting with each other. What lies ahead for professionals in finance? What is the outlook for those who manage portfolios, trade derivatives, underwrite securities,  borrow funds, invest in big projects, advise clients on retirement planning, and advise companies pondering a merger?

In the post-financial-crisis era, finance professionals are accustomed to volatility and uncertainty.  The two terms are portrayed as variables, statistics and concepts in theoretical finance. Today, they are a way of life. Just when signs point to a full-fledged economic recovery, from around the corner come a momentary slowdown or unsettling gyrations in markets--caused by factors or events previously unaccounted for:  Mideast uprisings, Greece, bipartisan politics, Spain, Italy, China, and the lingering reluctance of U.S. Congressmen to agree on anything. Markets become volatile because they can't handle, measure or project uncertainty or the impact of unforeseen events.

It has become the new normal for finance professionals, complicating how they manage portfolios, assets, balance sheets, funding needs, and foreign currencies. To be prepared, they must brace for the next startling event that unleashes itself to cause havoc in capital markets.

Some events, nonetheless, aren't uncertain in the year to come. They will occur, and bank managers and traders will spend much of 2013 and beyond wrestling with them.

New bank regulation and reform is for real. It's about to happen. The politics, debating and fretting over Dodd-Frank and Basel III are diminishing. The implementation has become. Large banks, broker/dealers and trading firms are hustling to prepare for a new world of restrictive rules of capital requirements, leverage, and trading.

Hence, new regulation will dictate how financial institutions do business, generate revenues, organize their global operations, and expand.  Most of the new rules require banks to hold more capital now, more capital next year, and even more capital in the years to come.  The new rules restrict proprietary trading and require extensive vetting, analysis and approval of new financial products.  Gone are the days when banks could amass large trading positions in options or commodities or when a coterie of bankers with math doctorates could design a derivative one month and trade it profitably with hundreds of counter-parties the next.

With increased amounts of capital set aside to support the same business, they can't generate or reach targeted levels of return on equity. If banks have an ROE (NPAT/Equity) target of 15%, then new capital above the old capital implies (a) they can't borrow as much to support existing business levels and balance sheets, (b) they must squeeze out more revenues from the same business model and/or (c) they must wring out costs from existing businesses.

This week, with revenue growth uncertain, Citigroup decided it needed to slash costs to address the same issues. It announced major plans to cut businesses and trim staff by 11,000--partly to bolster its ROE while meeting the growing capital requirements. 

With the new normal of uncertainty and the periodic slowdowns in recovery, like Citi, other financial institutions, too, are zooming in on cost control and business efficiencies to meet ROE targets. No business line or activity, it seems, is exempt from a revamping, a re-engineering, or a shut down. Some are selling off or closing businesses to meet performance targets; some are choosing to redeploy resources, attention and hiring toward business units already above ROE targets.


Fixed-income.  These business units (corporate bonds, mortgage bonds, structured finance, public bonds, high-yield debt, leveraged loans, etc.) at many financial institutions are under the gun right now. With thin profit margins on trading and lending activity and low fees from underwriting, some banks can't rationalize existing business. Not being able to make it work, many are withdrawing from fixed-income businesses or reducing their scope or capital deployed to support it.   

UBS announced this fall that it was virtually shutting down activities in this sector, while it contracts in investment banking overall. Other banks, too, are painfully making fixed-income decisions. A few more will persevere with hopes of gaining market share from banks exiting the business.


Asset management. New regulation won't overwhelm asset-management sectors as much.  They don't require substantial amounts of new regulatory capital (not much beyond the capital required to support infrastructure).  Financial institutions are, therefore, swarming to the apparent benefits of this sector:  less-onerous regulation, stable revenues, and everybody's projections regarding savings habits among consumers or corporations hoarding cash.  Even this month, Goldman Sachs announced plans to push this segment harder in global frontiers.  

For these reasons asset management--and variations of it (from private wealth management to investment management and institutional client management)--will get attention from bank senior management. Because of such attention, financial institutions will find ways to expand, grow assets under management, offer new products and hire researchers, investors, portfolio managers and client managers.


Risk management. In the years after the crisis, financial institutions everywhere beefed up their risk-management units to prepare for the next black-swan event or Lehman-AIG-Bear-Stearns collapse.  Many had units, people and systems in place, embedded in much of the trading and banking organization.  Risk managers were already detecting, managing, approving and projecting risks (and the exposures, defaults, non-performing assets that arise from those risks).  In recent years, however, financial institutions have tweaked governance and increased the authority of risk managers--given them more institutional power to act, make impactful decisions, raise flags and stop bad banking behavior. 

In the last year or two, risk management now incorporates a bit of compliance, arguably a growth industry in finance these days.  Banks and broker-dealers, now more than ever, require professionals who must interpret the thousands of pages of Dodd-Frank, decipher Basel II and III, and help build systems to monitor capital, leverage and liquidity. Opportunities abound for those who can master the rules, have the discipline to monitor them, and can explain their precise impact on business activity.

Compensation for experts in risk management and compliance sometimes lags that of those on the glamorous front lines.  Some institutions have taken proper steps to close these differences. Others need to. 

Equities.  Equity units aren't suffering as much as fixed-income units, partly because profit margins and fees on equity activity (trading, market-making, underwriting and investing) are higher, despite the worrisome volatility in markets, the anxiety of retail investors and the hesitancy of some client companies to issue new stock. Higher margins and fees explain how banks with equity prowess and market share can rationalize the business and keep in humming--in hopes volumes will once again reach pre-2008 peaks.


Corporate Banking.  Renewed  emphasis in corporate banking has surged in recent years, as major banks see value in old-fashion corporate lending, corporate cash management, custody and processing.  Managing corporate relationships from day to day results in satisfied clients, who provide a steady flow of business and revenues--in good times and downturns. Corporate banking, if risks are managed and harnessed, can meet the ROE hurdles, even with Basel II and III rules keeping tabs on corporate-loan volume.

Derivatives.  "Derivatives" has been the ugly word of finance since the finance crisis. Since then, derivatives have resurfaced in different forms and ways.  They (interest-rate swaps, credit-default swaps, options, warrants, etc.) are still useful corporate hedging tools and weren't legislated out of existence by new reforms.  New regulation now requires that most of them should no longer be traded "over the counter," "by appointment" or at the whims of large institutions.

New reforms will require they be traded and cleared more transparently on exchanges and at approved clearing organizations, so trading participants can see prices, volumes and counter-parties. This upends the trading and market-making models at big banks, which for years gushed at high margins and their ability to strong-arm markets in the way they could. New reforms will slash those margins and profits.

The new trading schemes for derivatives are still under review and subject to vast restructure. Banks, trading firms, broker/dealers, hedge funds, exchanges and clearing firms remain at the drawing board planing how interest-rate swaps and credit-default-swaps and other derivatives will trade going forward. Nervous, they are still unsure how they'll generate sufficient profits to meet ROE targets.

Some banks and firms will retreat; others will try to pick up the slack and make money from volumes and technology efficiencies. For most, it will still be a question mark for 2013 and forward.


Hiring and recruiting.   Financial institutions still hire with the same recruiting habits--massive hiring when the market picks up, massive reductions when threats of a downturn appear. Amidst the profitability challenges and cost-control campaigns, there will be reductions or limited recruiting in some segments (fixed-income, sales/trading, e.g.). They are offset by opportunities in areas where banks are confident earnings will be stable and expansion less risky:  asset management, corporate banking, consumer banking, e.g. Better opportunities exist, too, for those willing to go abroad (Southeast Asia, Brazil, e.g.).

In good times and bad, amidst market bubbles or threats of a system collapse, financial institutions still make their appointed rounds on campus at top business schools. They make their corporate presentations, identify students they covet, and hold interviews. Actual hiring tends to be erratic, but they maintain relationships, always hoping for that sustained market turnaround.

Compensation.  Compensation is always tricky, sometimes bewildering, often one grand puzzle. Media stories dare to project compensation in financial services (bonuses, first-year base salaries, total packages for senior bankers, etc.). Often the stories reflect the sentiments of one or two institutions and are based on quick interviews with a handful of executive recruiters.

For the most part, bonus packages in current times tend to (a) be as volatile and as uncertain as markets, (b) reward those designated as top performers, and (c) be a grab bag of cash, stock, deferred arrangements and even debt securities these days. Many large banks in the past five years have reduced bonus payouts substantially, but have offset that with significant increases in base pay.

Compensation overall may have trailed off, but most packages have been and will likely continue to be attractive for the best of the lot.

Diversity

Markets are volatile, and so is the emphasis financial institutions place on diversity--whether that's diversity at entry levels or diversity at the most senior rungs.  Most institutions devote more attention at the lower professional levels and neglect it at the senior levels. At levels above vice president, they tend to allow the numbers to be whatever they are.

As 2013 approaches, diversity (no matter how it is defined or what it encompasses) has forged its way back onto corporate priority lists at most financial institutions.  During the crisis, diversity initiatives, programs and targets became a forgotten agenda item shoved into the back of the drawer. Today, with a bit of optimism, the major institutions see and feel the benefits of a more inclusive organization. Smaller firms (hedge funds, private-equity and venture-capital outfits, e.g.) haven't quite bought the benefits.

In 2012, diversity highlights culminated with Goldman Sachs' fall announcement that 14% of its new partners were women. Even in 2012, people applauded the 14%, a figure that hints at notable progress when compared to numbers from other years. But 14% still suggests that we still have a long way to go.

In all, whatever is happening in Washington will keep the industry from storming out of the starting gates, as 2013 launches. But most in the industry sigh and feel comfortable 2013 won't be 2008 or 2009.

Tracy Williams

See also:

CFN:  Approaching 2012, Dec-11
CFN:  Opportunities in 2012, Dec-11

Jefferies: Comfortable in its Niche

In finance circles, Jefferies, the mid-sized, New York-based investment bank, is a "tweener"--too big and mature to be a young upstart, but not  large or imposing enough to earn the label "bulge bracket" or "too big too fail." Like a Knight Capital or MF Global, if Jefferies were in danger of sliding into oblivion, government regulators and market counterparties would let it go.

Amidst all the post-election squabble about "fiscal cliffs" and recent stomach-churning market volatility, Jefferies quietly slipped into the business news this month. It agreed to be acquired by its minority owner, the conglomerate holding company Leucadia.  The transaction won't shake the broker/dealer world. It may hardly move anybody in any way.

But it brings to mind the consistent, stable performance of a niche investment bank, one that has always been too small to be a threat of any kind to behemoths Morgan Stanley, Goldman Sachs and JPMorgan. Yet it is one that is a bit too large to be called a specialized boutique (like Greenhill or Evercore) and too broad in scope to be a Lazard.  The quiet acquisition reminds us how one firm through decades of incarnations and shake-ups has survived when others (bigger and better known) like Bear Stearns and Lehman couldn't.

MBA students interested in banking and finance usually don't know the firm as well as it should. Jefferies is not widely known to criss-cross the country to visit top business schools and make flashy corporate presentations, hungry to recruit the best MBAs. And some might rate its diversity  record slightly less than satisfactory.  Bankers and traders across the globe are from various ethnic groups, many backgrounds and countries. The board of directors and executive committee, however, appear to be a club of long-time Jefferies executives--with virtually no representation from under-represented groups (women and minorities).  

The firm, which used to promote itself the go-to investment bank for the "middle market," has endured its share of troubles, problems and scares. When the dust often settles--whether they were insider-trading problems years ago or European-debt turmoil of a year ago, Jefferies appears to wipe itself off and proceed with its normal course. Or it sometimes swoops in to purchase the valued pieces left behind by other firms that failed.

The acquisition by Leucadia will come with synergies and provide a resource for more capital, if and when it needs it. (Leucadia, known also to be a "Baby Berkshire," manages private investments in multiple industries.) Jefferies will continue its business as usual. In times when capital is king, Jefferies likely decided that it should have a parent that could provide capital at a moment's notice--without it having to fall into the hands of the big boys like JPMorgan or Credit Suisse. Jefferies can now have access to capital, but still be Jefferies after all.

The bank manages a diverse array of businesses (sales & trading, investment banking, equities, fixed-come, precious metals, and brokerage) with a $3.3 billion capital base--too large to be called a pure-advisory boutique like Greenhill or Moelis, too small to be in the league of Goldman or Morgan Stanley.  To its credit, it has never aspired to go head-to-head with Morgan Stanley in most of its business lines.

Years ago it pronounced itself as the favorite investment bank for middle-market clients, seizing upon a niche that even the boutiques and bulge-brackets often ignored.  Growing, middle-market companies are enterprises that issue modest amounts of new equity and high-yield debt to support growth. Jefferies elected, too, to tap aggressively into the high-yield niche, when boutiques couldn't do so and the bulge-brackets wavered about their commitment to "junk bonds."

The bank has certainly withstood its share of storms. Its founder, Boyd Jefferies, got caught in the whirlwind of insider-trading scandals of the 1980s. At the time, the firm was better known as a "third market" trading firm, making markets in equities after normal trading hours. More recently, as the financial crisis unfurled, the firm got caught with excessive amounts of high-yield and mortgage securities on its balance sheet (just like its larger peers). 

Last year, when the whole world watched the crumbling state of finances in Greece and Spain, market watchers turned suddenly to Jefferies and wondered whether the firm was overloaded with European debt or other related exposures.  Rumors swirled, and its stock price tanked. When MF Global collapsed, partly because of excessive Europe exposures, financial markets wondered if Jefferies would be next. Markets always play a guessing game of who's-next. Some made unfair, ungrounded accusations about what toxic waste might be hiding on Jefferies' balance sheet.

Somehow Jefferies escaped that tumult and pulled through to have a stellar, profitable year in 2011.  In 2012, it's on its way to a $250-million-plus earnings year (good enough for a respectable 8-10% ROE).

Every other year, there are industry shake-outs. While firms like DLJ, Drexel Burnham, A.G. Edwards, Alex Brown, Hambrecht & Quist, Montgomery Securities and L.F. Rothschild have disappeared to the back financial history books, Jefferies plods along. Richard Handler is its CEO, who roared often when others claimed the firm was overloaded with Greek exposure, and will also become the head of Leucadia.

A strategy of remaining comfortable and aggressive within its niche, allowing itself to seize pockets of opportunity when they arise, has probably made the difference. It would, however, be nice to see it do better in diversity at its top rungs.

Tracy Williams

See also

CFN:  MF Global and Its Collapse, 2011
CFN:  Knight Capital's Darkest Day, 2012

UBS Throws in the IB Flag

UBS, the Zurich-based global financial institution, announced last week that it plans to dismiss 10,000 employees as it continues, like most big banks, to review, revamp and re-scale its business units around the world.  That's not an unusual news item. In financial services, that's a news blurb we see almost every other day.

UBS provided more details.  Most of the dismissals will come in its investment-banking group.  More specifically, its fixed-income businesses will suffer the most.  The dismissals, the down-scaling and shrinkage are unfortunate. The announcements are, nonetheless, not shocking, since they are a common event in the business press.

This might, however, be the first wave of dismissals in finance, where the bank stepped up to admit  blame solely on its inability to justify business lines because of hefty capital requirements from the new wave of regulation. UBS says new regulation (in Switzerland and from the reforms of Basel II, II.5, and III, and new Dodd-Frank and Volcker rules) will require substantial increases in its equity capital base just to continue doing existing business. And barring any spectacular periods of revenue growth, the increases in capital will push down returns on equity to levels that can't be explained to shareholders.  About as simple as that.

(See CFN on Basel III, 2010 for more background on Basel regulation. In effect, the combination of Basel and Dodd-Frank would virtually double the capital requirements at large banks (those commonly thought to be "too big to fail") between now and 2019. The requirements will step up in increments over the years.)

For all practical purposes, UBS has decided to withdraw from huge-scale investment banking after having decided years ago to attempt to be a bulge-bracket bank.  It has decided it can't make the numbers make sense for it to be a Top-10 investment bank.  Sure, it will continue in certain niches--equities, research, brokerage, and investment management.  But it will not try to compete head-to-head with Goldman Sachs, JPMorgan, Deutsche Bank, and Morgan Stanley.

UBS, through the years, had built up its investment-banking practice through acquisitions, corporate-banking relationships, the reputation of its investment-management and private-banking businesses and the heft of its capital base. Some may recall how in two decades it penetrated U.S. borders by acquiring the well-known retail brokerage Paine Webber and the boutique firm Dillon Read. It absorbed those operations years ago and used them as a base to compete in the U.S. in many areas.

UBS's rationale makes some sense.  It articulates that it seeks to generate a return on equity (ROE) from 12-17 percent. That varies with business cycles and market volatility. On average, it strives to seek returns of 15 percent.

New regulation throws a thorn into its side.  The bank must, as it has done the past year or so, reduce leverage, get rid of bad assets, and push costs down significantly. It also had to deal with the $2 billion loss of a rogue trader, repair risk management and trading operations and improve controls.  While sprucing up controls and balance sheet, new regulation comes along and adds the burden of boosting capital and taking leverage down even more.

If it decides that it must boost capital by 10-20 percent, then ultimately it would need to increase net earnings by 20 percent or more. Increasing net earnings in the current environment--one of uncertainty, volatility and fierce competition from the other big banks--might be near impossible, unless UBS decided to cut costs vigorously.

So where do you cut costs? You do so in businesses where regulation will require big increases in capital, where profit margins are already slim or vulnerable and where costs can be cut swiftly.  Its fixed-income businesses (corporate bonds, municipal bonds, government bonds, interest-rate derivatives, corporate lending) became the first target of deep cuts. This includes (within fixed-income units) corporate-advisory activity, underwriting, trading and market-making.

Senior management may have deduced that, at best, ROE would hover around 5-7 percent in those businesses. ROE in the range of 0-5 percent for a business that already uses up significant amounts of capital would be a certain drag on the bank's overall ROE.  An unsatisfactory result for shareholders, who too dream of earnings growth, stock-price increases and a nice, reliable dividend.

UBS Investment Banking won't go away. It requires a certain amount of investment banking (underwriting, market-making, securities distribution and equity research) to complement other profitable or growing business lines:  investment management, private banking, brokerage, and corporate banking. Yet with massive departures in London and in fixed-income activities, there will be minimal activity in corporate bonds, short-term instruments, mortgage securities, structured securities, private placements, subordinated debt, mezzanine debt, interest-rate swaps, and any of the products and activities that fall under the fixed-income spectrum.

UBS in its announcements hints this is not a cowardly business act. It claims to be making a tough business decision (at the expense, unfortunately, of thousands who must seek employment elsewhere) that all of its old peers must inevitably make over the next few years. It is patting itself for making that decision now.

Tracy Williams

See also:

CFN:  Basel III and Capital Cushion, 2010
CFN:  Big Banks and Dreadful Downgrades, 2012
CFN:  JPMorgan Chase and Regulatory Rants, 2012
CFN:  Big Banks and Where Do We go from Here? 2010

CFN:  The Volcker Rule, 2010
CFN:  The Volcker Rule, Part 2, 2011